A joke currently making the rounds has God offering to grant a man one wish in thanks for all the good things he has done in his life. The man (let’s make him a California resident) asks God to build a highway across the Pacific Ocean to Hawaii, making it easier for the man to get to his favorite place on earth. God suggests that might not be possible, and asks the man for an alternate wish. The man — let’s make him a healthcare economist — asks God to help him understand how drug companies price their new products. God then asks the man how many lanes he wants in his highway.

In a capitalistic society, most companies price most products based on 1) how much it costs to make them, and 2) how much the competitive marketplace will allow. In the Bizarro World of pharmaceutical pricing that exists in the U.S., most companies price their products based on a system that is unidentified, unanalyzable, incoherent, illogical, unknowable, incomprehensible, impenetrable, inexplicable — in other words, completely un-transparent.

For most chemical-based products, the costs of manufacturing seem almost totally irrelevant to their pricing. Those costs seem more meaningful for companies making biologics, due to the changing nature of the media, the reactions, and the yields. Yet the differences in the pricing of a patented product compared to its generic equivalent suggests that it is market competition, rather than manufacturing costs, that becomes the main determinant of any particular product’s price.  

The costs of development are quite relevant to the prices all pharma manufacturers charge for their products. But it’s impossible for outsiders, and probably for insiders too, to calibrate the precise costs of developing any particular drug. Doing so would require allocating to each successfully developed compound its share of the costs of the people and facilities used in conducting all the appropriate laboratory, preclinical, and clinical testing required for approval.

That exercise would still ignore the costs of conducting basic research, and conducting the laboratory, preclinical, and clinical testing on potentially druggable compounds that did not become commercial products. Those who suggest ignoring the costs of research that does not lead to a successful product are just not being reasonable. It would be nice if companies could clearly separate their R&D costs into the two buckets of “those involved in developing our successful drugs” and “those involved in basic research activities and on compounds that never became drugs”. That challenge reminds me of retail pioneer John Wanamaker’s famous lament: “Half the money I spend on advertising is wasted; the trouble is, I don’t know which half.”

Would the drug industry’s critics better understand the rationale for setting prices if the companies published more information about their methods of allocating direct and indirect costs? Companies in other industries provide information about “Operating costs excluding unallocated corporate expenses” for various business segments. Could drug companies do the same, using Therapeutic Categories, Phases of Research, or other relevant categorizations in place of Business Segments?

Would the companies regain any of their lost respect among the public by disclosing how much of their annual research budgets involve the type of basic or applied research that aims to seek better understanding of a biological process and is not necessarily expected to lead to the development of a drug? The public seems to believe only the National Institutes of Health conducts such research. They might understand that even the smallest amount of such research needs to be embedded into a firm’s total costs of development, and also reflected in the pricing of its products.

The cost of prescription drugs represents only about 15% of our country’s healthcare bill. While that number is much higher than it was 30 years ago, it’s undoubtedly true that drugs developed during that period have enabled the reduction of hospital expenses for treating numerous conditions — and helped improve and prolong the lives of patients afflicted with them.

I’m not the first person to suggest that the drug industry needs to figure out better ways of communicating the story of its remarkable contributions to improving the nation’s health during the past few decades. But I might be one of the few to ask it to stop shooting itself in the foot by hiding behind a veil of secrecy when pricing its products.